Jeremy McPhail

Accountancy and financial advice specialist, Crowe Horwath, has urged investors to maintain a long-term approach to their investment portfolios and avoid pushing out of defensive assets in pursuit of stronger returns.

Released yesterday, the Crowe Horwath 2014 Ten Best Investment Ideas Half Year Progress Report provides an update on 10 key themes and trends identified at the start of the year by Crowe Horwath’s financial advisors, investment analysts and economists, to help investors make sense of and take advantage of these trends.

Commenting on the report, Crowe Horwath Head of Research Jeremy McPhail said the sustained low interest rate environment was fuelling investors’ appetite for investments offering higher returns.

“It’s important to remember that defensive assets form an invaluable component of any well-balanced investment portfolio and investors should ensure these assets are bedded-down before exploring riskier investments. Investors should also watch out for innovative investments that promote high yields with sustainable growth opportunities and focus on absolute returns rather than relative returns.”

Mr McPhail said that change remained the only constant and investors should remember that planning and securing a comfortable financial future is now more important than ever.

“The one constant for investors is change – social, political, technological and financial, and measures such as those outlined in this year’s Federal Budget, remind us that securing a financial future is more important than ever.

“Over the course of 2014 so far, there has been a high level of geopolitical tension plus domestically we’ve had a national review into the financial system and financial planning scandals that have caused investors to question who they can trust for genuine financial advice. There are a lot of moving parts for investors to digest,” he said.

“It’s certainly making for an interesting investment environment but what we are telling clients is try and distance yourself from that noise and focus on what you can control.”

While investors shouldn’t disregard events such as the current international tensions in various parts of the world, Mr McPhail said it was important to recognise that there are always some negatives and in most cases, investors with a portfolio of quality investments constructed around their long-term goals will be well placed to ride out any volatility.

“There has been plenty of uncertainty over the past 12 months but equity markets have still had another strong year, with returns of over 5% from the 200 largest domestic listed companies and over 8% including income.”

Key opportunities for investors

Nominated as a key theme for investment opportunity in the 2014 report is the acceleration of and rapid response to technology. According to the report, companies investing in infotainment and online shopping are worth investors’ attention, while cloud computing and companies spending on R&D and displaying high levels of productivity and competitiveness are also highlighted as worthy of consideration.

Growth in China and other emerging markets also continue to represent strong opportunities, according to the paper.

“Growth is continuing in China but as we have pointed out for some time now, that growth is changing to become much more focused on consumption. Consumers in China and India are hungry for an authentic brand experience, either at home or abroad and companies tapping into this, such as those seeking to acquire Treasury Wines, partly for their coveted Penfold’s brand and LVMH, which purchased half of Australia’s RM Williams business in 2013, are worth investors’ attention,” said Mr McPhail.

Other investment opportunities identified in this year’s paper include Australia’s travel industry, which is likely to benefit from the changing demographic shift as baby boomers retire and travel more, as well as growing inbound tourism from emerging nations.

“The pick-up in overseas travel by Chinese and Indian nationals is a positive for companies such as Westfield and Sydney Airport, and we continue to favour exposure to these companies as they look to benefit from these trends.”

Crowe Horwath’s top ten ideas for 2014:

1. Focus on your goals, not the Jones’s – Consider your personal goals and needs when setting your investments
2. Change – The only real constant – Baby boomers approaching retirement are changing where consumption is occurring
3. The innovators – Innovation is not just good for consumers but it is producing businesses that are more efficient and producing tangible shareholder value
4. Servicing the demographics – Again! – With a retiring population, aged care facilities demand will outstrip supply
5. The new political regime – With businesses holding back spending due to the 2013 Federal Election, cashed up companies are likely to be looking at mergers and acquisitions in 2014
6. Urbanisation and the growth of the middle class –  Urban population is now greater than rural globally and will lead to different consumer spending patterns
7. Where to invest offshore? – The outlook for global economies is mixed but will mainly be driven by the ongoing recovery in the US market
8. Yield does not equal income – Don’t fall into the ‘yield trap’ but look for quality stocks with both rising dividends and share prices
9. Infrastructure and property – the new annuities – Cash is returning less than inflation so look to mature property and infrastructure for income streams
10. What to do with the banks? – If you own for income, they still provide and attractive yield but they appear fully priced for growth

The Ten Best Investment Ideas provides a roadmap for investors and businesses looking to navigate the political and economic changes which may shape 2014 and beyond. Click here to to obtain a copy of Crowe Horwath’s Ten Best Investment Ideas Half Year Progress Report.

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• Australian companies are maintaining very liquid balance sheets. Corporate Australia held a record $271.4 billion in cash and deposits as at September. As a proportion of total financial assets, companies held 30.7 per cent of financial assets in cash – the highest in 11 years
• Super fund holdings of cash assets rose to a record high $162.9 billion in the September quarter. The proportion of super funds (pension funds) assets held in cash remained unchanged at 15.4 per cent in the June quarter, well above the decade average of 9.2 per cent.
• The financial wealth of Australians rose sharply in the September quarter – largely due to 7.2 per cent rise in equity markets. Net financial assets of households rose by 8.0 per cent after sliding by 8.7 per cent in the June quarter.
• Per capita financial wealth rose by over $3,000 to just under $44,000 in the last quarter. Financial wealth is down 17.8 per cent below the record set in late 2007.
• In seasonally adjusted terms imports rose by 4 per cent in November supported by a 8 per cent lift in capital goods imports.

What does it all mean?

• Australian households have plenty to cheer about with wealth levels repairing in the September quarter. Financial wealth is holding just shy of the two year highs reached in the March quarter and given the recent rally in equity markets it is likely to surpass those levels when the December quarter wealth figures are released. As the recovery gains traction the improvement in wealth levels should support confidence, and in turn translate to an increase in spending and overall economic activity.
• Interestingly company balance sheets are certainly looking much healthier with Corporate Australia held a record $271.4 billion in cash and deposits as at September and the proportion of total financial assets, companies held in cash is now at the highest level in 11 years.
• The unpopularity of high gearing levels has seen domestic companies pay down debt significantly, and the uncertainty surrounding the global recovery and lacklustre activity has seen business hold back from committing to investment plans.
• It’s not only companies that are cashed up, Australian superannuation funds are holding almost double the ‘normal’ proportion of money in defensive assets like cash and bank deposits. That is not to say that super funds have not been investing in equity markets rather the equity investments have been less than the cash inflows record by fund managers. No doubt as the global economy strengths and the recovery look more concrete pension funds will feel more comfortable with allocating a larger proportion of inflows to growth assets.
• Super funds are spoilt for choice at present, given the attractive yields being offered on term deposits, however the longer that fund managers maintains an abnormally high proportion of money in defensive assets, the greater the risk that returns will underperform its competitors. A combination of factors such as new fund inflows, asset allocation decisions, and valuation changes should underpin further growth of the sharemarket over 2011. We expect the All Ordinaries & ASX 200 indexes to lift to around 5,400 by December 2010.
• Over the three months to September, foreign investors were certainly maintaining their love affair with Australia, purchasing an additional $23.8 billion of Aussie shares in the past quarter. Over 40 per cent of listed shares are held offshore, highlighting the importance of foreign investors in driving our sharemarket.

What do the figures show?

• The net financial wealth of Australian households (assets less liabilities) rose sharply by 8.0 per cent in the September quarter after sliding by 8.7 per cent in the June quarter.
• Financial assets of households (such as shares, bank deposits) rose by $88.3 billion or 3.7 per cent in the September quarter to $2,472 billion. Financial liabilities of households grew by $15.4 billion or 1.0 per cent to a record $1,491 billion.
• Overall, net household financial wealth (assets less liabilities) rose by $72.8 billion to $980.8 billion at the end of September quarter. Financial wealth is up 1.7 per cent on a year ago but is still down 17.8 per cent from the record high set in the September quarter 2007.
• Net household wealth per capita rose from $40,580 to $43,638. Per capita wealth is up only 4.7 per cent over the past five years and up 29.3 per cent over the past decade.
• The household debt to liquid assets ratio fell by 4.8 percentage points to 159.6 per cent in the September quarter. The ratio shows that households do not have sufficient readily liquefiable assets to cover outstanding debt, highlighting a degree of vulnerability in the current economic environment.
• The share of foreign (non-resident) holdings of Australian listed shares fell from 42.9 per cent in the June quarter to 41.2 per cent in the September quarter – easing further away from the 12 year highs of 43.3 per cent reached in March 2009. Overall foreigners bought a net $23.8 billion of Australian equities in the September quarter, compared with selling $41.3 billion in the June quarter.
• Pension fund holdings of cash & deposits rose by $6.1 billion to $162.9 billion in the September quarter – a record high. The proportion of super funds (pension funds) assets held in cash largely remained unchanged at 15.4 per cent in the September quarter, remaining well above the decade average of 9.5 per cent.
• Corporate Australia held a record $271.4 billion in cash and deposits as at the end of September. As a proportion of total financial assets, companies held 30.7 per cent of financial assets in cash – the highest in 11 years (since September quarter 1999.
• Net financial assets held at private companies (non-equity assets less loans) stood at a record $77.4 billion at September. Australian companies are maintaining very liquid balance sheets.

Merchandise imports

• Imports rose by 4 per cent in seasonally adjusted terms in November according to the Australian Bureau of Statistics. Consumption goods imports rose by 1 per cent, intermediate goods rose by 4 per cent while capital goods rose by 8 per cent.

What is the importance of the economic data?

• The Australian Bureau of Statistics releases the Financial Accounts publication each quarter. The data covers assets, liabilities and financial flows for the key sectors of the economy. Figures on financial wealth help reveal the true state of household finances.
• The ABS figures on imports refer to physical goods such as cars and computers. The figures are not adjusted for seasonal effects. The data is useful in highlighting the strength of consumer and business spending and gives some guidance as to the likely trade position in the month. But analysis can be clouded by currency changes.

What are the implications for interest rates and investors?

• Equity markets are likely to remain well supported over coming months. The latest round of data has confirmed that super funds still remain heavily underweight equities. Super funds are holding almost double their traditional amount in cash and as fund managers become more confident about the economic recovery more money will be put to work in the share market.
• In the longer run, the strength of domestic companies, and in particular the resilience of the Australian economy will no doubt be a strong drawcard for foreign investors
• CommSec expects the All Ordinaries & ASX 200 indexes to lift to around 5,400 by December 2011.

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In releasing the Diversified Sector Report, Zenith Investment Analyst Graeme Miller said from an initial group of 109 Diversified products:

• 3 were rated HIGHLY RECOMMENDED and
• 22 RECOMMENDED.

The 25 Funds that were rated RECOMMENDED or above have been placed on Zenith’s Recommended List and are candidates for client model portfolios.

Of this number, 11 Funds are new additions to Zenith’s Recommended List.

Given the high threshold required to achieve a HIGHLY RECOMMENDED rating, only 2 investment managers and 3 funds have attained this rating at the completion of this sector review. These funds are:

“Additionally, this year Zenith surveyed its client advisers and sought to provide them with additional insight they in turn may utilise to address many of the questions and issues they encounter when providing wealth creation, financial and retirement strategies for their clients,” said Graeme Miller.

Specifically, the three key areas of concern were:

• Is it appropriate for investors to have a heavy ‘home-country bias’ to Australian Equities?
• Is investing in term-deposits for income a sound investment strategy?
• How does Zenith fit Emerging Markets into a strategic asset allocation?

Home Country Bias

Several industry commentators have recently pointed to Australia’s relative economic health and strong growth prospects as justification for maintaining a high weighting to Australian Shares in a diversified portfolio.

Graeme Miller responded, “Zenith however, does not agree that a having a strong homecountry bias is optimal from a risk-adjusted returns perspective. Our principal concern lies in the increasing concentration in the Australian market, which is heavily weighted in the volatile resources and financials sectors.”

Zenith contends that two key drivers of these sectors – commodity prices and household debt, are both at historically high levels, which presents risks that should be managed prudently from an overall portfolio perspective.

Term Deposits and Investing for Income

A popular strategy amongst income-focussed investors has been to invest predominately into term-deposits.

Whilst term deposits are close to ‘risk-free’ in terms of the security of the cash flow received, they can also be considered a high risk strategy for those looking to invest for income whilst maintaining their standard of living over a prolonged period of time.

“One alternative to the above approach (which Zenith advocates) is to blend a number of income sources across asset classes, maturities, and risk levels, to ensure a well diversified flow of income that incorporates some protection against inflation,” said Graeme Miller.

Emerging Markets

There has been a continued push by managers to increase their exposure to Emerging Markets, which has given rise to the issue of what International Shares benchmark is most appropriate.

Zenith believes the use of the MSCI All-Country World Index (ACWI) is much more relevant for the purposes of performance evaluation, as at present managers are able to outperform MSCI World by including Emerging Markets exposure.

Classification of Defensive Asset Classes

Within a diversified portfolio, it must be ensured that defensive allocations are truly ‘defensive’ in nature.

Graeme Miller said, “This issue is part of a broader industry problem of inconsistent naming conventions being used for managed funds.”

“In reviewing Diversified Fund offerings, Zenith obtains full underlying portfolio data, which is then reclassified according to our own internal definitions of Defensive and Growth asset classes.”

“This allows us to make more accurate comparisons between funds, and results in funds being categorised according to their Defensive/Growth asset allocation. For example, the Advance Balanced Fund is classed by Zenith as a ‘Growth’ Fund, whilst the Perennial Capital Stable Trust is classed as ‘Moderate’.”

Zenith is confident the inclusion of responses and insights to current investor issues and concerns will be well received by the national research provider’s adviser clients that it will be incorporated as a feature or addition in future Sector Survey Reports.

For further information or a copy of Zenith’s Diversified Sector Review and Report, please contact –

John Nicoll
National Sales Manager
Zenith Investment Partners Pty Ltd
Tel (Direct): +61 3 8639 1212
Email: john.nicoll@zenithpartners.com.au

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What is the role of research houses now? Following the performance of the majority of research houses over the last three to four years – combined with the financial ombudsman ruling last year that now implies financial planners must conduct their own research – a lot of advisers are wondering if they even need to use a research house.

Are research houses now redundant? Or can they change with the times and actually start adding value to the financial advice process?

What value do the major research houses really provide to financial planners anyway? They did little or nothing over the last few years to assist financial planners and their clients to navigate their way through the financial crisis.

The role of a research house should be to scrutinise fund managers and their products, and exclude them if they are sub-standard, and to then let financial planners know the basis of their recommendations. It should not be the aim of research houses to appease fund managers by making it easy for them to get on the recommended list.

Research houses may need to consider to stop taking money (or is that bribes?) from fund managers for ratings so they can be unbiased and transparent in how they develop their recommendations.  Of course, they will then need to increase the fees they charge financial planners.  But this would then result in planners demanding a better service and more accountability from the research houses.  That would be a good result, but I can’t see it happening soon.

Financial planners feel there are a number of anomalies surrounding the output they receive from research houses, including:

• Asset allocation recommendations seem to remain static no matter where markets are placed.  They are the same today as they were during the bull market – shouldn’t there be some adjustment to take into account the value of markets today based on future forecasts?
• What have research houses done to beef up their research capability so that toxic investments are not recommended… or at least are weeded out in a timely fashion?

Most financial planners feel that research houses have not added value to the financial advice process, in fact many of their recommendations put financial planners and their clients in harm’s way.

For example, in 2006 and the first half of 2007 you didn’t need to be Einstein to work out that equity markets and commercial property markets (both listed and unlisted) were generally extremely over-valued.  And yet financial planners had little or no guidance from the research houses, and their asset allocation recommendations to planners didn’t change. This resulted in clients being hit hard when the inevitable correction came.

Further, the so called defensive portfolios contained within some research houses’ model portfolios proved to be not so defensive, with clients taking significant losses on the defensive portion of the portfolio, with no chance of a rebound on lost capital (as is generally the case with blue chip equities following a crash).

Why did this happen?  Was it because those research houses were chasing high returns on high risk fixed interest vehicles such as Basis Capital? I would love to know how some research houses justified shoe-horning  Basis Capital and other high risk investments into the defensive portfolio of their models.

Why chase high returns on the defensive portfolio anyway?  If the client needs higher returns, consider allocating more to growth assets provided they are not overvalued. Defensive assets should be exactly that – defensive.

Over the last 12 months many bond funds have continued to perform poorly due to a combination of interest rate risk and credit risk – and yet they continued to be recommended by research houses.  And still are.  Why be in these funds while interest rates appear to be only going one way – up. Consider that term deposits have proved to be very effective defensive assets over time, with the added advantage that clients know exactly what return to expect from term deposits. I find that there is a certainty about the outcome with term deposits that provides clients with a lot of comfort.

Financial planners and dealers alike recognise they are liable for the advice they provide to clients.  Therefore, if they can’t rely on the support and recommendations provided by research houses, they may as well do it all themselves by developing in-house capabilities.

Surely this option wouldn’t provide a worse result than the one we experienced over the past four or so years when we relied on the research houses?

To be honest, I would still prefer to rely on the research houses… but they need to lift their game first!

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